An introduction to start-up investment: From SEIS to EIS
Interested in investing in start-ups but not sure where to begin? The investor world can feel exclusive and inward-looking – but things are changing.
Most investors typically join networks or angel groups through peer invitation, which keeps them closed off to people outside of the traditional business networks.
As a result, potential investors from ethnic minorities have missed out on opportunities to join investment groups and learn from peers. There’s a huge market of untapped potential; Ethical Equity is here to support it.
In this article, we’ll explain the basics of how start-up investment works and how you can get involved.
Where start-ups turn for investment
The traditional investment process starts with a founder putting a business plan in place and working on the first version of their product (also known as a minimum viable product). The idea is to validate their idea, so they can seek the funding they need to grow.
The next step is to reach out to angel investors. An angel investor is a high-net-worth individual who invests their own money in a business, usually in exchange for a small stake in the company.
A start-up founder will often connect with these investors through angel groups or syndicates. and get them involved at seed or pre-seed level:
Pre-seed funding is an early funding round where a start-up’s founders raise funds to get their idea off the ground
Seed funding is the first official funding stage
Supporting a business at this stage involves a lot of risk – they haven’t proven demand for their product and many fail. However, investors that are willing to back early-stage start-ups stand to gain a large reward if they’re successful.
While angel investors need to buy into the idea, we often hear about them investing in the founders – something we’ve experienced ourselves at Ethical Equity.
They will look at the founder and consider: is this the right person to take the business forward? Do they believe in the product and what they’re trying to achieve?
The typical background of angel investors
Most investors who make up angel groups will fall into one of these categories.
Senior executives
These are senior executives of large organisations like law firms, accountancy practices or FTSE 100 companies, who are interested in investing in start-ups. For these investors, it often starts out as a hobby and then turns into something more serious over time.
People who have already exited
These investors will have already built a business and successfully sold it, and want to find new opportunities. They tend to be more savvy in terms of where they invest, because they’ve been through the journey themselves.
There are also people who fit one of the following personas:
They’re in a senior role but don’t know where to start with investing. These people might turn to crowdfunding platforms and invest without being part of a group or syndicate
They have rental portfolios and would be interested in potential investment returns elsewhere
They’ve inherited (or retired with) a large amount, either in cash or assets
Making the investment community accessible
At Ethical Equity, we’ve created an investment platform to support start-ups that have a positive social, environmental or cultural impact.
We’re open to everyone who is interested in this space, giving them the chance to connect with like-minded peers and learn about the process, so they can start investing with confidence.
Our ethical focus gives impact-driven angel investors access to start-ups that might not go through traditional syndicates or make it through the doors of their angel groups. Find out more about registering as an investor with us.
The investment journey you’ll go on with a start-up
If you’re fairly new to the world of investment, there are two main schemes for investors in early-stage businesses.
The Seed Enterprise Investment Scheme (SEIS)
The Seed Enterprise Investment Scheme (SEIS) provides tax incentives for investments in early-stage start-ups that are just starting to trade. Since it’s focused on newer businesses, there’s more risk and you’ll need to make your own judgement on the founders and what the company is trying to do.
There’s also more focus on mentoring and helping to unlock networks for the founder, rather than simply putting in cash and expecting a return in five years’ time.
SEIS allows start-ups to raise a maximum of £150,000. Usually, individual investments range from between £5,000 to £50,000. The tax savings are very attractive and help minimise the risk, provided the individual angel has paid enough taxes to offset against the relief.
The Enterprise Investment Scheme (EIS)
The Enterprise Investment Scheme (EIS) focuses on more established businesses and start-ups can raise up to £5 million each year.
Investments normally start at around £50,000 and above. However, like the SEIS, you can always commit to much lower amounts like £10,000 or £20,000.
At the EIS stage, the company is more advanced and has somewhat minimised the risks throughout the growth stage.
If you invest in the SEIS or EIS schemes, it’s best not to expect a quick return. Your money can be locked in for a ten-year period, as it can take that long to get to an exit (where a founder sells the business) or a liquidity event (where founders and early investors can exchange shares for cash, eg. during an acquisition).
So you’ve invested in a start-up through the SEIS scheme – what happens next?
If the business hasn’t started trading yet, they’re required to spend at least 70% of the cash before investors can claim relief back. If they’ve already commenced trading, you can claim your relief back quite quickly.
Most businesses will have enough cash for the next 12 to 18 months – this is called their runway. Once they’re nine months in, they’ll start looking at another round of fundraising to expand further or to scale up, depending on their cash position.
If their first round was pre-seed, this will be a seed round which is much bigger. It’s usually up to half a million pounds, though you do see seed rounds around the one million mark too.
Investing through EIS
When the start-up starts fundraising more in a seed round, additional shares will be issued which will decrease the percentage you own of the business. If you want to keep your percentage as an investor, then you’ll be required to invest further into the business.
That can sound daunting, but if you’ve been providing support and mentoring the business, you should have a clearer idea of how the business works and confidence in where it’s headed.
If the business still excites you as an investor and you still believe in the idea, you might invest through the EIS – at this point, SEIS will no longer qualify. Under the EIS, you might put in another £50,000 or £100,000, depending on your tax and financial position.
Since the company should be in a stronger position, the valuation will be much higher. That means that while your stake may decrease as larger rounds happen, it’ll be worth much more.
Finally, you can keep investing through further rounds to hold or even increase your percentage. The business might go on to do a Series A round for example, a significantly larger funding round.
We’ll be covering Series A in more depth soon, so keep an eye on our blog.
Register to invest at Ethical Equity
At Ethical Equity, we help ethical start-ups and scale-ups to connect with like-minded investors, just like you.
Find out more about the benefits of ethical investments or start your investment journey by registering as an investor here. You can also get in touch with us here.
